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Summary: Choosing a suitable budgeting method for your business can be challenging. Finding what fits best to your business model and needs requires paying attention to numerous factors — operational, financial, supply chain & logistics, market trends, and customer preferences. This article will focus on the five most common budgeting methods that companies across industries implement and shed light on their benefits and drawbacks.
1. Incremental budgeting
In this method, the current year’s budget is obtained by adding or subtracting a percentage from the last year’s actual figures. It’s one of the easiest ways to calculate the budget and is used by most companies. This method makes sense if the primary cost drivers don’t change every year.
As the name suggests, this method determines the total cost required to achieve the anticipated level of activities in a particular duration. It takes a top-down approach for identifying and analyzing the activities that drive cost. This rigorous analysis allows allocating resources for achieving activities that were planned beforehand.
For example, you are a washing machine manufacturer. Your next year’s forecast projects a cumulative sale of 1,000 units. Each washing machine has the same Cost of Goods Manufactured (COGM) of Rs. 10,000. Then, according to ABB, you should compute a budget of Rs. 1,00,00,000 (1,000 * Rs. 10,000).
Companies that adhere to the ZBB method of budget accounting build a budget from scratch. They start from the baseline of “zero,” meaning that analysts can examine and justify expenses of all sizes — big or small.
ZBB helps determine which activity adds real value to the business and is worth keeping and which ones can be discarded.
In performance-based budgeting (PBB), specific goals are identified and marked. Then budgets are defined for each of those activities, and a set of actions are planned.
This methodology focuses on the objectives and goals that an organization wants to achieve, and therefore it helps build a result-oriented culture. Companies also design Key Performance Indicators (KPIs) to facilitate this practice.
In this method, companies continuously add a new budget period after the previous one expires. The rolling budget methodology involves the gradual extension of the existing budget model. Therefore, a business that follows this methodology always has a budget that extends 12 months in the future.
Drains a lot of time: Budgeting becomes a monthly or quarterly activity instead of a yearly function.
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